New Zealand Credit Law Bulletin - Vol 7, No 3, March 2007
A free, plain English review of recent law and items of interest for creditors, produced by Hattaway & Associates Ltd, Credit Consultants. To subscribe, visit the New Zealand bulletin index and enter your details on the right
Plain language disclaimer:
This bulletin is not legal advice. Do not make decisions on legal matters based on a brief commentary. Instead, get professional legal advice.
In this issue:
- Transfers between companies prove expensive for directors
Money-go-round scheme to reduce ACC premiums backfires - Privacy nonsense - involving family members in a personal matter
Recent privacy case note on a problem similar to that often faced by credit staff - Court of Appeal decision on the second PPSA case
CA affirms High Court decision on the racehorse case - Creditor tries to replace liquidators it doesn't have confidence in
Liquidators had rejected creditor's proof of debt for $178 million
1. Transfers between companies prove expensive for directors
Merilyn and Michael O'Connor were the directors of Upstairs Ltd. They got some advice from a sole practitioner accountant (who later joined Ernst & Young). As they understood it (and there were doubts that they did understand it), they would save on ACC premiums for management staff if they set up a family trust, borrowed money from ASB Bank using their house as security, then on-lent it to a new company which would carry out the management side of the business for a management fee.
Accordingly, their family trust borrowed the money and in May 2001, paid $249,000 to Upstairs Ltd. Upstairs immediately paid $200,000 to Effective Fencing Ltd, a new company they had set up. The O'Connors jointly owned all the shares of Effective Fencing with Elizabeth Neill. The O'Connors were the only directors of Effective Fencing.
It appears Upstairs may have acquired some of Effective Fencing's employees. John Maio, an employee of Upstairs, went to the Employment Relations Authority with a claim for unjustifiable dismissal. Upstairs was ordered to pay him about $10,000. When Upstairs did not pay - which the judge pointed out was because Effective Fencing did not give it any money to do so - Maio successfully applied to have Upstairs placed in liquidation.
The liquidators demanded that Effective Fencing pay back the $200,000 under s 298, "Transactions for inadequate or excessive consideration with directors and certain other persons." For a contract to exist, each party must receive something of value, and that "something of value" is known as consideration. S 298 is designed to stop failing companies from entering into unfair contracts for the benefit of those who control the business. If there wasn't any real consideration, but Upstairs gave Effective Fencing $200,000 without getting anything (or anything of real value) in return, then the transaction could be overturned, and Effective Fencing would have to pay back the money to Effective Fencing.
The liquidators applied for summary judgment in the High Court and won. This meant that the O'Connors, through their family trust, had borrowed $249,000, left $49,000 in a company which had gone bust, and the other $200,000 was now going back to the company in liquidation, where it would be used to pay the liquidators fees and split amongst all the creditors (rather than simply repaying the family trust).
Effective Fencing appealed to the Court of Appeal on three grounds. It argued that there was consideration. However, the Court of Appeal said "Upstairs received no benefit from its $200,000 payment to Effective Fencing. Indeed, all it potentially got were liabilities!"
Second, they argued that the two companies weren't under the same control because "when viewed as separate persons neither [Mr or Mrs O'Connor 'controlled' Effective Fencing". Each was one of two directors so neither, on their own, had a majority vote on any decision. The Court of Appeal disagreed. "The directors of Upstairs (the O'Connors) undoubtedly controlled Effective Fencing. The O'Connors were Effective Fencing's sole directors and the O'Connors, as shareholders, controlled the Effective Fencing board."
Lastly, Effective Fencing argued that they should have been allowed to involve Ernst & Young as a third party to the action. The Court of Appeal said, "[t]he only reason Upstairs went into liquidation was its failure to meet the judgment Mr Maio obtained against it. Had the O'Connors put Upstairs in funds so that that debt could be paid, Upstairs would not have gone into liquidation and s 298 liability could not have arisen. It is extremely difficult to see how Ernst & Young can be liable in these circumstances..." The appeal was dismissed.
Back to top
Information on our current seminars
2. Privacy nonsense - involving family members in a personal matter
A woman worked as a volunteer with responsibility for processing a school's book club orders. The school principal became aware that there were problems relating to the orders. (The nature of the "problems" wasn't specified but readers can probably imagine.) He rang her but got no response, so he visited the woman's home. Despite knocking on both the front and back doors, and calling out, no one opened the door.
The woman's father lived next door. The principal went to the father's house and explained why he needed to speak to his daughter. Both men then returned to the house and the woman came to the door. She advised the principal she would attend to the outstanding matters and visit the school the following day. She did not keep the appointment.
The principal then wrote to her setting out what she had undertaken to do. According to the case note, principal copied the letter to the father "as it had been necessary to involve him previously."
The woman complained about the fact that the principal had twice involved the father.
Information privacy principle 11 prohibits an agency from disclosing personal information unless an exception applies. The Privacy Commissioner's view was that none of the exceptions to principle 11 applied. It was not necessary to involve the complainant's father.
The principal acknowledged that he had made an error of judgement. It was unclear to what extent the complainant had been embarrassed by the disclosures. As previous cases show (see for example,
http://www.hattaways.com/publications/bulletin/bullview.php?id=102#1 ) the "victim" has to show some harm in order to justify a penalty. For example, if the father had reacted by beating the woman, it would have been easy to show harm.
In this case, the school agreed to write a letter of apology, acknowledging that the principal's actions were inappropriate, and the Board members and the school principal attended a Privacy Act training workshop. The woman accepted this as an appropriate resolution.
This situation is comparable to the sort of thing often faced by credit staff. Be careful!
Back to top
Information on our current seminars
3. Court of Appeal decision on the second PPSA case
NZ Bloodstock Limited & Anor v Waller & Ors [2005] NZCA 254 (27 October 2005)
Readers of this bulletin, especially those with an interest in the Personal Property Securities Act, will recall the case in the High Court of the stallion "Generous". This matter was appealed to the Court of Appeal. The judgment is remarkably difficult reading but we can summarise it by saying that nothing changes!
To summarise the facts, briefly, in 1999, Glenmorgan Farm Ltd granted a debenture to SH Lock over the assets of Glenmorgan. In 2001 Glenmorgan entered into a lease to purchase (a type of hire purchase) agreement with New Zealand Bloodstock to acquire Generous. When the PPSA came into force, SH Lock registered its security on the Personal Property Securities Register. NZ Bloodstock didn't. Glenmorgan defaulted on both agreements. NZ Bloodstock repossessed the horse. SH Lock then appointed receivers to Glenmorgan. The receivers demanded that NZ Bloodstock give SH Lock the horse. SH Lock had registered thereby "perfecting" their security interest. NZ Bloodstock hadn't so their security interest was "unperfected". Section 66 sets out the general rule on priorities. It says that unless the Act says otherwise, "a perfected security interest has priority over an unperfected security interest in the same collateral". Bad luck for NZ Bloodstock. Generous was leased to an English company. The money received by NZ Bloodstock under this lease after they repossessed the horse, would generally be "proceeds" which were difficult to recover under the pre-PPSA law, but should be easier to recover under the PPSA. However, the confusing wording of the (pre-PPSA) SH Lock debenture document meant that the Court upheld the decision of the High Court that the matter was not straight-forward and needed a full hearing. Summary judgment was not awarded on this matter.
Back to top
Information on our current seminars
4. Creditor tries to replace liquidators it doesn't have confidence in
CWF Holdings Ltd was a trustee for a unit trust. Both CWF Holdings and its directors were closely associated with media company, CanWest Media Works (NZ) Ltd. In 1997, CWF Holdings contracted with Trinity Foundation (Services No 1) Ltd. Trinity was to grow trees on land it owned in Southland. Trinity was to get $50,000 per annum and, when harvest occurred in about 2048, a further $1.738 billion.
However, in 2005, the shareholder of CWF Holdings put the company into liquidation and appointed Downey and Black as liquidators. The liquidators disclaimed the contract, as they have the right to do under the Companies Act if they believe the contract is unprofitable.
One practical effect of the disclaimer was that Trinity, in effect, stepped into CWF Holdings' shoes to grow the trees for itself. Another effect was to transform a claim based on breach of the agreements (where Trinity was a secured creditor) into a claim for damages for loss. Of course, there is difficulty working out what the damages will be when the trees will not be harvested until 2048. Perhaps more importantly, the agreements were carefully drafted to limit the liability of CWF Holdings to Trinity to the funds held by CWF Holdings as trustee of the unit trust. At the time of the liquidation, it had funds of about $12,000.
Trinity was unhappy with having liquidators appointed, in effect, and funded by Canwest. Trinity was concerned that the liquidators were unlikely to look critically at the actions of the directors of CWF Holdings given that those directors were closely associated with Canwest. The exact nature of any claim against the directors was not spelt out, but presumably, Trinity hopes that they might be found to be personally liable.
Liquidators can be replaced at the first creditors meeting if a majority of creditors by number and value vote to do so. Before that meeting, Trinity's proof of debt for $178m was rejected by the liquidators. So they didn't get a vote and Downey and Black stayed on. If the liquidators are not removed by the vote of the creditors at that meeting, it's a much more difficult process to get rid of them.
Trinity asked the High Court for leave to challenge the liquidators' decisions. The Court would not give leave to challenge the liquidators' decision to disclaim the agreements, but permission was granted on 4 issues. In particular, Trinity had leave to argue before the Court that their claim should not have been rejected in its entirety and that the liquidators should not have continued as liquidators of CWF.
Downey and Black appealed to the Court of Appeal. Note that this wasn't an appeal on the actual issues, but simply on whether Trinity should have been given permission to challenge the liquidators' decisions in court.
At the Court of Appeal, the judges said that while the Trinity proof of debt was flawed, "we would have expected Messrs Downey and Black to have estimated the amount of the claim, or if they felt that that was too difficult, to have referred the matter to the Court for a decision... [W]e are left with the view that their original actions in rejecting the claim out of hand and proceeding with the creditors' meeting were arguably unreasonable. Messrs Downey and Black were perhaps unwise to instruct as their solicitors, the firm which has acted throughout for CanWest NZ. All in all it is not entirely surprising that Trinity should perceive them to be in CanWest's camp..." However, the Court accepted "that Messrs Downey and Black have statutory duties under the Companies Act and likewise accept that it would be inappropriate to infer bias (or anything similar) from the fact that they have an indemnity from CanWest."
The judges pointed out there were problems for Trinity in any claim against CWF Holdings's directors in excess of $12,000, because CWF Holdings' liability to Trinity is confined to the assets of the unit trust.
The Court of Appeal confirmed the High Court's decision to grant leave to Trinity to challenge the liquidators' decisions. With so much money potentially at stake, no doubt the parties will be off to court again to decide these matters.
Back to top
Information on our current seminars
